To our readers,
Until now I have had the pleasure of writing the majority of our blog entries, but am very happy to now present the writings of Juliana Cusack. Juliana is our analyst on the venture fund and works closely with investment team on economic matters. While I will continue to write the quarterly Market Updates and some Market Notes, Juliana will now be a regular contributor to this space.
Her first piece on Brexit is below. It will help to clarify some of the bigger issues was are facing as we head into the summer months.
Thanks,
David
On June 23rd, Britain will vote on whether to ‘Remain’ or ‘Leave’ the European Union (EU) in a move that has significant implications on the US’ biggest ally and the broader European community. The sentiment underpinning this vote is strong and frustrated. The vote itself was a concessionary promise made by David Cameron to a swath of reluctant supporters during his last campaign. While it seemed unlikely to materialize, thirteen days to go and the ‘Leave’ camp is leading by a percentage point in the
polls, with 12% still undecided.
The ground-swelling of anti-European sentiment is in large part due to the expansion of the EU in geography and scope, as well as the emergent and fragmented terrorist threat. But like the Trump factor here in the US, the impact of globalization and displacement of blue collar jobs has exacerbated these issues and laid the foundation for xenophobic and isolationist attitudes to take hold. A discussion of each of these factors follows below.
Trade
Trade is arguably the most important aspect of the European ‘project’, with the European Union initially established as a duty-free trade alliance. The EU currently absorbs 44% of British exports, linked to 3.3 million British jobs. The severity of the impact is, of course, debated and subject to post-exit negotiation, but if the UK left, trade would likely be governed by the WTO, where members can impose tariffs on imports that average 9% when no preferential deal is in place. The relative increase would almost certainly hurt both UK exports and consumers.
Moreover, firms located in London are currently granted a ‘passport’ allowing them to operate in other EU countries without undergoing separate regulatory oversight. This has implications particularly for London’s substantial financial services sector, which currently benefits from being able to clear transactions denominated in euros, a function not possible after an exit. While more limited free trade deals have been negotiated, as with Switzerland, Canada, and Norway, they are unlikely to be lenient in negotiations given the signaling towards the already weakening European unity and the competitive position of the UK’s financial sector.
No one, except European capitals eager to fill the void if London were to exit the Common Market, is arguing the trade benefits that come from membership. If anything, ‘Leave’ supporters are most frustrated with the EU’s evolution beyond a trade alliance, but are still confident that loss of trade will be made up for by trade with China, India, and the US.
Immigration
‘Leave’ supporters are certainly fired up about the EU limiting Britain’s ability to control the number of immigrants reaching their shores, a fact blamed for decreasing wages and an overheated real estate market. Part of this is due to the unprecedented enlargement of the EU. When free movement to the UK for citizens of new EU members was first agreed to in 2004, 100,000 migrants were expected in the first decade after enlargement. In the end, it was 1.4 million, roughly half from the original member states and half from the poorer new members of Eastern Europe. Eastern European arrivals are more likely than previous migrants to settle in small towns, presenting challenges for local authorities. And in fact, the loudest voices in the ‘Leave’ camp come from outside of the capital.
Terrorism
The issue of terrorism is delicately intertwined in immigration issues, particularly given the disparate and concealed threat posed by ISIS. Many people believe terrorists can slip in undetected with streams of migrants, only made worse by the imagery provided by the attacks in Paris and Brussels.
Consider the fact that Ibrahim El Bakroui, an organizer of the Brussels attack was put on a watch list in Istanbul after being arrested near the Syrian border, but no information was provided to Belgium authorities after he was sent back. Cooperation between France and Belgium would also have been prudent as attackers, originally planning to target France, easily shifted their plans to Brussels given their freedom of movement. Local police in Molenbeek, Belgium, also failed to pass on key information regarding the hiding place of the last remaining Paris attacker for three months.
Figure 1: A map indicating EU and Schengen membership across Europe highlights the issue of terrorism prevention when information is not shared between countries with open borders. source: ec.europa.eu
Europe faces unique challenges in preventing terrorism given their porous boundaries, bureaucratic complexities, and inclusion of former-Soviet territories. While the UK is not a member of the Schengen Zone, this prevents the tracking of dangerous persons and strengthens terror networks across borders. Each EU member, including those with freedom of movement, has different legal frameworks and rules on the classification of secrets. Europol has been at the heart of intelligence-sharing initiatives, but the authority has no ability to make arrests and has been slow to garner buy-in from its members.
Political
The issues around trade, immigration and terrorism are all significant. But some also say that moreover, this is a struggle over identity. The UK is separated from the rest of Europe by language, geography, and culture. As the NYTimes put it, “In [the pro-Brexit] view, the country is being overrun by foreigners who not only take their jobs and welfare benefits, but also bring fundamentally different values into Britain.”
The European Union offers the UK a platform to spread its values and participate among its allies in the fight for human rights and safety in difficult times. This participation offers significant benefits. But the cost of that is a loss of sovereignty to European officials, unelected by the UK populace but whose laws make up 15% of the UK’s total. People also focus on the UK’s contribution to the EU budget, which totaled 13 billion GBP in 2015.
Image 2: An image from the Opening Ceremony of the London Olympics in 2012 celebrated an eccentric image of British culture throughout the decades.
Your Portfolio
Since polls showed a tip towards the ‘Leave’ camp earlier this week, the FTSE 100 Index (UKX) fell -3.49%, the Euro Stoxx Pr Index (SX5E) fell -4.58% and the S&P 500 fell -1.12%. Global fund managers’ allocation to UK equities are at the lowest levels since 2008 and the pound fell against all 16 major peers. Nevertheless, many say markets are still not prepared for a ‘Leave’ vote, and there would certainly be further fallout for global markets, and the UK and Europe in particular.
There is not much European exposure in the portfolios though there is a small amount of the Vanguard FTSE Europe ETF (VGK), which was added in July 2015. The ETF had a low in February but has been crawling back since. We have also had a rocky time with Santander (SAN), which has been subject to the European instability as well as internal challenges brought on by new leadership. Nevertheless, volatility is dangerous and market events are all felt across borders, including here in the US.
